This website requires certain cookies to work and uses other cookies to help you have the best experience. By visiting this website, certain cookies have already been set, which you may delete and block. By closing this message or continuing to use our site, you agree to the use of cookies. Visit our updated privacy and cookie policy to learn more.

This Website Uses CookiesBy closing this message or continuing to use our site, you agree to our cookie policy. Learn MoreThis website requires certain cookies to work and uses other cookies to help you have the best experience. By visiting this website, certain cookies have already been set, which you may delete and block. By closing this message or continuing to use our site, you agree to the use of cookies. Visit our updated privacy and cookie policy to learn more.

Engineering Economics Goes Green

What
financing challenges did the first ancient Egyptian engineer face?
After setting the table with that interesting scenario, we move on to
modern engineering economics. There, calculating the cost of
generating one dollar of savings is joined by the value of assessing
the oft-overlooked cost of doing nothing. The result is a stronger
argument for sustainable building and retrofitting in the
contemporary age, and that’s no pyramid scheme.

Simple
payback might have, in the past, been effective in justifying
engineering projects. However, with today’s availability of widely
diverse energy-savings initiatives, more sophisticated tools may be
needed if we’re to do a reliable and credible economic analysis of
an energy-savings project.

Going back to
ancient Egypt, many historians believe that Imhotep was the first
engineer (and architect), since he is credited with designing the
Step Pyramid for the Pharaoh Djoser in the 27th century BC. It is
unlikely, however, that engineering economics was a part of the
process on that particular project, since its budget - if one
existed - does not seem to have been recorded. However, when the
Great Pyramid was built a century later, its cost of 1,600 talents
was noted. Depending upon whether these were gold or silver talents,
that project in today’s dollars would likely be in the range of $50
million to nearly half a billion U.S. dollars.

And,
although the concept of “interest” was apparently recognized by
then (in 2000 BC, the Babylonians paid interest on the grain they
borrowed1),
it is probably a safe assumption that the project was “pay as you
go,” particularly since there’s very little chance of an ROI from
a tomb! Or is there? Perhaps Cheops’ son, Radjedef, put in a
fast-food franchise and started selling tours of Dad’s tomb
…

If that were the case, what would the
economics of the enterprise have looked like? If we examine the most
basic model of simple payback, with cash flow coming entirely from
tour ticket revenues - without any regard to operating or
maintenance costs, the time value of the money (assuming they had
actual money then, which is problematical); or risk - and we assume
that: (1) the price of admission is one 3,600th (1/3,600) of a talent
(equivalent to a Babylonian shekel, with apologies to academia) and
(2) an expected average attendance of 10,000 visitors a day, 365 days
a year, then the model would look like:

This
model is, of course, very simplistic. It does, however, point out a
significant limitation of simple-payback analysis, which is its
inability to compare different solutions on an “apples to apples”
basis or to other potential investments (uses of the same money) or
even to not making any investment. That may not have been a problem
in ancient Egypt, but in today’s business environment, more precise
tools are obviously required, and simple payback is more typically
used on discrete capital projects with clearly defined operational
savings.

The challenges of the ancient
engineers - perhaps even through the time of da Vinci and his
Renaissance colleagues - were far more technical than economic.
That probably changed with the Industrial Revolution, and today the
study of engineering economics is a frequently required part of an
undergraduate engineering curriculum and one of the subjects covered
on the Fundamentals of Engineering (FE) examination.2
And in reality, the economic hurdles facing an engineering project
today are often more daunting than are the technical obstacles. Any
engineer who’s had to “sell” a high-first-cost project to a
recalcitrant client, or to his or her top management, knows this to
be fact.

Economics And Energy Efficiency

o
what, exactly, is engineering economics and how is it specifically
applicable to energy-efficiency projects, particularly those whose
costs are mostly “soft”? According to one definition,
“Engineering economics, previously known as engineering economy, is
a subset of economics for application to engineering projects.
Engineers seek solutions to problems, and the economic viability of
each potential solution is normally considered along with the
technical aspects.”3
Watts and Chapman go on to say that, “The role of engineering
economics is to assess the appropriateness of a given project,
estimate its value, and justify it from an engineering standpoint.”4

One would correctly expect, then, that
engineering economics would rely heavily on recognized financial
concepts such as present and future values, discrete compounding, and
discount factors, and that the challenge of justifying the cost of an
energy-efficiency project would depend largely on the ability to
accurately predict the energy savings. This has resulted in the
development of some interesting ways of examining these issues.

For example, in his work on energy systems in
agriculture and biomass fuel production, Professor Bryan Jenkins at
UC Davis has developed a revenue-requirements approach to determining
the energy revenues required to earn a desired ROI.5
And Christopher Russell has pioneered the concept of energy volume
at-risk and the annualization of project costs to account for the
useful economic life and time-value of the investment.6

According to Russell, if the formula for
Capital Recovery Factor – which is the reciprocal of Uniform Series
Present Worth (P/A,i,n), where P equals present value, A equals
constant annuity, “i” equals interest rate, and “n” equals
number of periods - is used, with i now representing the cost of
capital or discount rate on future cash flows and n representing the
useful economic life (in years) of the proposed solution (energy
improvement project), then

i(1+i)nCRF= A/P = [(1+i)n]-1

This model allows an
annualized cost analysis and for a capital project involving
equipment having a predictable useful economic life (n), it works
well. For example, if a 10-year-old, low-efficiency, 13-ton packaged
rooftop unit were to be replaced with a new, high efficiency RTU, the
model might look like this:

Total installed cost of project = $25,000

Useful economic life of RTU = 20 yrs

Internal cost of capital = 6%

Current
cost of energy = $0.08/kWh and $12.50/kW demand = $0.10/kWh average

Energy consumed by old RTU = 131,659
kWh/yr

Energy consumed by new RTU =
77,699 kWh/yr

Energy saved =
131,659-77,699 =53,960 kWh/yr

Therefore,
from the formula above

CRF
= .06(1+.06)20
=0.087 [(1+.06)20]-1

The annualized cost
to save 1 kWh would be:

Project
cost x CRF
= $25,000
x .087
= $0.04 Energy saved 53,960

The cost-to-benefit
ratio, then, would be

Cost
to save 1 kWh =
$.04/$.10 = 0.40 Current cost of energy

In other words, an
investment now of 40 cents will avoid an energy cost of one dollar.

With a payback
of approximately 25% of the life of the equipment, this project might
still be undertaken, but the economic model is not nearly as
compelling.

Taking this process one step
further, if we consider n to be the expected continued occupancy of a
facility, we can use this model to evaluate the costs of energy
improvement solutions having an undefined or indefinite useful
economic life (e.g., software that is provided with continuous
upgrades) or solutions having a life expectancy that is longer than
the contemplated occupancy or lifetime of the facility itself.

In this case, the cost of doing nothing is
particularly significant, since a new LEED®-certified commercial
building may have a design life expectancy of 100 yrs.7
This model also gives us the flexibility of evaluating the true value
of upgrading/replacing equipment based on the incremental efficiency
improvements in that type of equipment that may occur early in the
product’s projected economic life. With the improvements in design
and manufacturing technology making rooftop package units with EERs
of 14.311 available today, this becomes an important consideration.

For example, if we take the case of a
hospital considering the implementation of building oversight
management, there is no finite useful economic life of the solution
and there is no “equipment” involved. The solution is, rather, a
process - a combination of an advanced monitoring capability
(software) with a method for managing real-time energy costs. This is
accomplished by hosting the data (collected by the software process)
in an operations center staffed by experienced engineers.8

If we assume a total first cost (initial
implementation plus monthly monitoring for the first year) of

$147,000 (project
cost)

Occupancy of the present
facility anticipated to be another 10 years min. (n)

Internal cost of money = 6.5% (i)

Current
cost of energy = $0.11/kWh

Expected
energy savings = 1,463,173 kWh/yr

Using our model

CRF
= 0.065(1+.065)10
= 0.14 [(1+.065)10]-1

Annualized
cost to save 1 kWh:

$147,000
x .14
= $0.014 463,173

Cost/benefit =
$0.014/$0.11 = 0.13

In
this case, an investment of thirteen cents avoids one dollar in
energy cost. Although the simple payback is less than one year
regardless of the expected occupancy or cost of capital, the ongoing
economic penalty for not doing the project is clearly demonstrated
and compared using this approach. Based on the variables used above,
the cost of not implementing the project is $385/day for the next 10
yrs, or >$140,000 in unnecessary energy costs.

And if we lower the
cost of capital or discount rate, or increase the anticipated
occupancy period, then the value of the project becomes even more
compelling.

And, finally, there are the
non-financial economic considerations to be evaluated. Although that
sounds incongruous, the implementation of cap and trade carbon
credits - although non-financial by definition - has a
significant economic impact. And it’s reasonable to assume that the
U.S. will join the European Union (EU) in imposing such a plan, since
- as a visit to President-elect Obama’s website will confirm -
he has endorsed cap and trade.9

The world’s largest carbon credit trading
system, the EU Emissions Trading Scheme (EU ETS) has shown that
although the economic considerations are significant, non-economic
considerations form the allocation of the CO2
allowances.10
So
the decisions to make or buy, replace or repair, are not as simple in
a world going green, and tools beyond simple payback are required.

We don’t fault Radjedef for not
commercializing his Dad’s tomb and missing the opportunity of being
the greatest entrepreneur of his day, but failing to recognize
significant economic opportunities in today’s world could make us
wish we had a tomb to hide in! ES

Larry is currently director of Corporate Business Development at Hill York, Florida’s oldest and largest air conditioning contractor, a post he has held since 2007. His previous experience includes such diverse assignments as president, vice president of sales and marketing, and regional sales manager at MEPCO (formerly the Dunham Div. of Dunham-Bush); and regional sales manager at Vapor Power. He holds a B.S.E.E., graduate study in management science from Virginia Tech, is a LEED AP, a member of ASHRAE, USGBC (South Florida), IEEE, AIA Florida (allied), and an associate member of the NSP/Michigan Society of Professional Engineers.

Engineered Systems magazine’s May 2020 issue examines the revitalization of air-cooled chillers in data center facilities, the viability (or lack thereof) of duct systems, the impact the coronavirus is having on the built environment, and much more.